The Legal Department and the Institute of the IMF held their eighth biennial seminar for legal advisers of central banks of member countries on May 7-17,2000. The papers presented in this volume are based on presentations made by the seminar participants. The seminar covered a broad range of topics, including activities of the IMF and other international financial institutions, sovereign debt restructuring, the architecture of the international financial system, and money laundering and the financing of terrorism. In addition, participants addressed the role of central banks, payment systems, securities, technology in the financial sector, and monetary arrangements.

The United States securities law framework may be perceived as a model to be adapted to the culture and needs of other jurisdictions.1 Included within this framework are issues focusing on insider trading practices. Examining U.S. law on this subject, however, reveals a regime that at times fails to accord fair treatment to market participants and impedes commercial certainty.2 Countries abroad thus may be ill served by embracing the U.S. model in this area. Indeed, with respect to insider trading regulation, a survey of the securities laws of developed markets reveals that these countries have rejected the U.S. approach.3 By adhering to an insider trading proscription premised on participants’ equal access to material nonpublic information,4 a number of these countries reflect the U.S. law in the pre-Chiarella5 era.6

Given the ambiguity and complexity of U.S. law in the insider trading area, Congress and the Securities and Exchange Commission (SEC) may be advised to assess the regulatory framework in certain other countries and determine their feasibility of application to the U.S. system. It may eventuate that key principles readily can be implemented from favored securities jurisdictions in order to enhance the clarity and efficiency of the U.S. framework.7

Regardless of its purported shortcomings, the U.S. securities regime maintains a critical component that other countries thus far have failed to achieve: an enforcement framework, based on government as well as private actions, that enhances compliance with the law and facilitates the levying of sanctions should violations occur.8 Effective enforcement is the key attribute of the U.S. securities law framework that distinguishes it from the regulatory structure existing in other countries. Hence, although the contours of U.S. securities law in the insider trading area may need refinement, effective enforcement elevates the U.S. framework to preeminence among securities markets. Briefly put, it is far more beneficial for achieving market integrity and investor confidence to effectively implement imperfect (yet palatable) securities laws than have admirable statutes that are rarely or episodically enforced.9

This chapter thus focuses on regulation of insider trading in developed securities markets. First, the U.S. regime is discussed. Thereafter, the securities laws of selected developed markets are addressed in order to provide contrasts to the U.S. approach. Last, the discussion focuses on a number of significant issues that merit exploration.

U.S. Regulation of Insider Trading

Preeminence of Federal Law

The following discussion examines key aspects of U.S. law in the insider trading area. With respect to insider trading regulation, federal law is the primary source of regulation.10 Although some states, such as New York, allow derivative suits against inside traders based on unjust enrichment11 and perceived injury to the corporate enterprise,12 state law often is unavailable in this context.13 For example, the nonrecognition by state courts of an insider’s disclosure obligation when transactions occur on impersonal securities markets14 as well as such courts’ refusal to find the requisite injury to the corporation15 signify that allegedly aggrieved traders must turn to federal law to seek redress.16

Section 16 of the Securities Exchange Act of 193417 governs short-swing trading by directors, officers, and 10 percent equity holders of publicly held entities. Pursuant to Section 16(b), such persons are subject to strict liability, requiring disgorgement of all profit, if they buy and sell (or sell and buy) an equity security of a subject entity within a six-month period.18 Section 16 raises several complex issues,19 including whether the statute has outlived its usefulness and should be repealed.20 This discussion does not enter the Section 16 fray, focusing instead on the securities acts’ antifraud provisions, which constitute the essence of insider trading regulation in the United States.

Rejection of Access and Parity Theories

Under U.S. law, no statute codifies the contours of the insider trading prohibition. Rather, the federal courts and the SEC are the principal actors. Prior to U.S. Supreme Court decisions in the 1980s, lower courts adhered to the parity of information21 and equal access approaches22 when interpreting the “disclose or abstain” mandate of Securities Exchange Act Section 10(b)23 (and SEC Rule 10b-524) in the insider trading setting. Under the parity of information theory, as enunciated by the U.S. Court of Appeals for the Second Circuit, “anyone in possession of material inside information must either disclose it to the investing public, or… must abstain from trading in or recommending the securities concerned while such information remains undisclosed.25 The equal access theory, a more narrow approach, posits that “[a]nyone—corporate insider or not—who regularly receives material nonpublic information may not use this information to trade in securities without incurring an affirmative duty to disclose.”26 In the matter of tipper-tippee liability, lower courts held that a tippee stood in the shoes of the tipper. A tippee knowingly receiving material nonpublic information from a tipper, when such tipper could not trade on that information, likewise was subject to the disclose or abstain mandate.27 As will be discussed in the following section, a number of countries by statute adhere to at least some of the foregoing principles.28

Today, the parity of information and equal access approaches for Section 10(b) purposes no longer retain validity.29 Rather, as construed by the U.S. Supreme Court, the breadth of the insider trading proscription under Section 10(b) is premised on principles based on fiduciary duty and trust and confidence.30 Other key concepts in this context include the materiality31 of the particular information and whether that information is confidential (namely, whether it has been adequately disseminated and absorbed by the investment community).32

Hence, as interpreted by the U.S. Supreme Court, trading on the basis of material nonpublic information by a director, officer, or other insider (e.g., a controlling shareholder) in the subject company’s securities is prohibited under Section 10(b) because, by engaging in such trading, such person breaches a fiduciary duty owed to the company and to the parties on the opposite side of the transaction(s), namely, the company’s shareholders.33 Accordingly, a disclosure obligation arises in this context from a relationship of trust and confidence among the transacting participants.34 Likewise, the subject company’s consultants, including lawyers, accountants, and bankers, who become privy to material nonpublic information with the understanding that this information must remain confidential, are defined as quasi-insiders and thereby are deemed to have a relationship of trust and confidence with the company and its shareholders.35 Such persons accordingly are subject to the disclose or abstain mandate, namely, that they must adequately disclose the material information to the marketplace or abstain from trading (as well as tipping) until such dissemination is effected.36 Nonetheless, insiders who elect to make adequate disclosure prior to their trade(s) (or tip(s)) violate the corporation’s need for confidentiality regarding such information and incur state law liability exposure.37

In regard to outsiders, namely, those individuals who do not have a fiduciary obligation to those who trade on the other side of the subject transaction(s), the misappropriation theory may be invoked.38 Under this theory, a Section 10(b) violation occurs when the subject actor misappropriates material nonpublic information for securities trading objectives, resulting in breaching a relationship of trust and confidence to the source of the information, irrespective of whether such source is or is not a party to the trade.39 Accordingly, an employee who misappropriates material confidential information entrusted to his or her employer and who uses such information for securities trading purposes breaches a relationship of trust and confidence with his or her employer and perhaps with his or her employer’s clients.40

Turning to unlawful tipping under Section 10(b), the critical inquiries are whether the tipper breached his or her fiduciary duty (or a relationship of trust and confidence) by communicating the subject information to his or her tippee(s) and whether the subject tippee(s) knew or should have known of the breach.41 Without the finding of a breach, a tippee may trade and tip without violating Section 10(b).42 Consistent with Supreme Court analysis, an insider is held to breach his or her fiduciary duty by tipping the subject information with the motivation of personal benefit. Such personal benefit normally is of a pecuniary nature, such as cash or elevation in status that will result in future financial benefits.43 A gift also is deemed a sufficient personal benefit: the gift of tipping the material nonpublic information is likened to actual trading by the insider and the transfer to the tippee-recipient of the profits generated from the trades.44

Rule 14e-3—Insider Trading in the Tender Offer Setting

In contrast to the Section 10(b) jurisprudence of insider trading is SEC Rule 14e-3, which applies only in the tender offer setting.45 In this limited context, the proscriptions against trading and tipping on material confidential information are significantly broader. Under Rule 14e-3, a person who obtains material confidential information regarding a tender offer directly or indirectly from the offeror (bidder), target corporation, or an intermediary neither can trade nor tip prior to adequate public disclosure (and absorption) of such information.46 In addition, a tippee of material confidential information relating to a tender offer who knows or should know that the subject information comes directly or indirectly from an offeror, target corporation, or intermediary similarly cannot trade or tip prior to adequate public disclosure (and absorption) of this information.47 Rule 14e-3 provides an exception to this expansive disclose or abstain rule for multiservice financial institutions that adopt and implement sufficient screening mechanisms that effectively prevent the flow of confidential information to those who effect or recommend trades in the subject company’s securities.48

Critique of U.S. Insider Trading Law

U.S. law on insider trading is far from laudable. Today, as a result of Supreme Court decisions, concepts focusing on fiduciary duty, misappropriation, and financial benefit determine the propriety of transactions consummated or contemplated. The objective of ensuring that ordinary investors are on an equal footing with market professionals to access material nonpublic information is no longer viable under Section 10(b) insider trading jurisprudence.49 Although Congress clearly intended the federal securities acts to extend greater investor protection than state law, the Supreme Court’s foremost reliance on state law premised on concepts of fiduciary duty slights that congressional objective.50

Indeed, the SEC, acting ostensibly within its rulemaking authority, has sought to minimize restrictive Supreme Court law. One example is the SEC’s promulgation of Rule 14e-3, which sets forth expansive parity of information and antitipping mandates in the tender-offer context.51 In the Section 10(b) setting, the SEC has advocated a broad construction of Supreme Court precedent,52 even prescribing new rules that in effect overturn lower court authority.53 In another recent regulatory action, the SEC adopted Regulation Fair Disclosure (“Regulation FD”), which that seeks to terminate the practice by companies of selectively disclosing material nonpublic information to market professionals and favored shareholders.54 While these selective disclosure practices constitute illegal insider tipping under the laws of many countries55 and indeed were illegal in this country prior to the Supreme Court’s decision in Dirks,56 such conduct is impermissible under Section 10(b) today only if the tipper is motivated by a desire to benefit personally from the selective disclosure.57

Some concrete examples illustrate the erratic treatment of insider trading law in the United States. One striking illustration is the different treatment accorded to tender offers due to SEC Rule 14e-3.58 Literally, an individual can legally retain profits by trading on material inside information or be held liable simply by the fortuity of whether a tender offer is implicated. For example, Barry Switzer, the former football coach of the Dallas Cowboys and the University of Oklahoma, inadvertently received material nonpublic information from a key corporate executive relating to a forthcoming merger transaction.59 Knowing the information to be reliable because of his relationship with the insider, Switzer (along with his cronies) traded on the basis of this information and made a handsome profit.60 In that the insider was unaware of Switzer being privy to the communications at issue, the court held there was no unlawful tipping.61 Because the tippee’s liability under Section 10(b) is derivative in nature,62 the finding that the insider-tipper did not breach his fiduciary duty signified that Switzer as the tippee traded lawfully and, hence, was entitled to keep his profits.63

The result in Switzer would have been entirely different if the subject transaction had been structured as a tender offer rather that a merger. In that event, Rule 14e-3 as well as Section 10(b) would have applied. Although Switzer would have avoided liability under Section 10(b), he would have violated Rule 14e-3 by trading on material nonpublic information that he knew derived from a reliable inside source.64 Hence, pursuant to Rule 14e-3, irrespective of the tipper’s liability, a tippee incurs liability by knowingly trading on material inside information that directly or indirectly derives from a subject corporation.65 Thus Switzer’s avoidance of liability and lawful retention of significant profits were owed to the manner in which the affected transaction was structured.

This inconsistency becomes more poignant when the Chestman66 scenario, involving a criminal prosecution, is considered. There, the Second Circuit en banc held that Chestman was not liable under Section 10(b) because his tipper breached no fiduciary duty by conveying material inside information relating to a forthcoming tender offer.67 Nonetheless, Chestman’s criminal conviction under Rule 14e-3 was upheld because he knowingly traded while in possession of material nonpublic information relating to a tender offer that derived, directly or indirectly, from a subject corporate source.68 Thus, while Chestman (like Switzer) avoided Section 10(b) liability because his tipper did not unlawfully tip, Chestman (unlike Switzer) was subject to liability because, unfortunately for Chestman, the structure of the transaction took the form of a tender offer rather than another feasible acquisition alternative, such as a merger or sale of assets. Such inconsistency cannot be reconciled with market integrity, investor protection, or basic concepts of fair treatment among similar market participants.69

The Chestman case has another troubling aspect. In ascertaining whether a fiduciary duty existed so as to trigger the disclose or abstain mandate,70 the Second Circuit held that marriage, standing alone, does not manifest a fiduciary relationship.71 To have such a relationship of trust and confidence, there must exist other attributes, such as an understanding to keep the material information confidential or a preexisting pattern of being privy to family business secrets.72 In addition to minimizing “family values,” one can understandably be concerned about the law giving greater sanctity to a shareholder’s relationship with a director of a publicly held company (with whom such shareholder has never spoken or met) than to one’s spouse, child, sibling, or parent. Such an approach is an outcome of the U.S. Supreme Court’s focus on the existence of a fiduciary relationship (or a relationship of trust and confidence) based on state law principles. Without a rule premised on equal access, state law notions of fiduciary duty can trigger, as they did in Chestman, an absurd result.73 By adopting Rule 10b5-2,74 the SEC effectively has nullified this aspect of Chestman. The rule implicates the misappropriation theory under Section 10(b) when a person receives material nonpublic information from a spouse, child, sibling, or parent unless such person can establish that, due to the particular family relationship, there existed no reasonable expectation of confidentiality.75 One can certainly question whether the SEC’s interpretation will be upheld.76 After all, the Commission in practical effect has “overturned” a decision rendered by the U.S. Court of Appeals.77

From an overall perspective, the conclusion seems inescapable that U.S. law on insider trading is far from ideal. Statutes are largely silent on insider trading,78 thus leaving this subject to the courts. The U.S. Supreme Court, rejecting the parity of information and equal access doctrines, has focused on traditional state law issues of fiduciary duty.79 This approach, in turn, as exemplified by the Chestman and Switzer cases,80 has led to illogical lower court decisions. On another front, the SEC, seeking to combat restrictive Supreme Court decisions under the Section 10(b) law of insider trading, has asserted expansive interpretations of those decisions.81

The SEC, thus faced with frustration regarding its now limited authority under Section 10(b), has responded by promulgating Rule 14e-3 and Regulation FD.82 The ultimate consequence is all too often the presence of inconsistent and erratic insider trading regulation that ill serves the investing public. Hence, the U.S. framework on insider trading is not one to be emulated. Other countries evidently agree.83

Regulation of Insider Trading in Other Developed Markets

Unlike the United States, where the law of insider trading largely has been formulated by the courts,84 countries abroad have enacted specific and detailed legislation defining the contours of the insider trading prohibition.85 Regardless of this codification approach, ambiguities exist in such legislation that await judicial or legislative resolution.86

Use of Statutorily Defined Terms

Unlike in the United States, key terms constituting the insider trading offense in other countries are set forth by statute.87 By way of example, the United Kingdom defines inside information as information that “(1) relates to particular securities or their issuers; (2) is specific or precise; (3) has not been made public; and (4) if it were made public would be likely to have a significant effect on the price or value of any security.”88 An “insider fact” under German law is “knowledge of a fact not publicly known relating to one or more issuers of insider securities or to insider securities and which fact is capable of substantially influencing the price of the insider securities in the event of it becoming publicly known.”89 Other countries similarly define by statute the elements of an inside fact or privileged information.90 In addition, other key concepts are defined by statute, including, for instance, those persons who are deemed insiders, having a special relationship with the company, or having access to insider information.91

Note that a number of interpretive issues remain under these statutes. Under the U.K. framework, for example, when is information “specific or precise” rather than general or not specific? Is information relating to the issuer engaging in relatively preliminary merger negotiations with a prospective suitor precise or not sufficiently specific for purposes of the statute?92 Under German law, when is a fact not publicly known so as to become an “insider fact”?93

Also, contrary to the U.S. definition, the concept of materiality is connected to the information’s impact on market price.94 The U.S. standard, focusing on whether the subject information would assume importance to the mythical “reasonable” investor making an investment decision,95 has not been adopted with great frequency elsewhere.96 To illustrate the widespread rejection of the U.S. definition of materiality, the laws of the following jurisdictions focus their inquiry on the information’s effect on the market price of the subject security: Australia,97 Canada (Ontario),98 France,99 Germany,100 Italy,101 Mexico,102 and the United Kingdom.103 Indeed, relatively few countries, such as Japan,104 follow the U.S. approach.

Hence, although awaiting judicial clarification of unresolved issues, the insider trading statutes outside of the United States set forth the key terms and definitions that comprise the offense. As will be examined below, the fiduciary duty (or trust and confidence) analysis embraced by the U.S. Supreme Court has been broadly rejected elsewhere.105

General Adherence to the “Access” Standard

Not surprisingly, other jurisdictions have soundly rejected the U.S. fiduciary relationship (or relationship of trust and confidence) model to define the scope of illegal insider trading and tipping.106 First, the U.S. approach focuses on the presence or absence of relatively complex inquiries to ascertain whether the insider trading proscription prevails in the particular setting. For example: Is there a fiduciary relationship present?107 What type of relationship is deemed to be fiduciary, or one of trust and confidence?108 Who is a quasi-insider and under what circumstances?109 What facts must be shown for there to be misappropriation of the subject information?110 Must the inside trader in fact “use” or merely be “in possession of” the subject information at the time of the transaction(s)?111 What must be established to prove that one tipped for “personal benefit” and what constitutes an “improper personal benefit”?112 To leave these inquiries to ad hoc adjudication and occasional SEC rulemaking113 may be tolerable for the United States with its zest for litigation and its abundance of lawyers, regulators, and judges. Such an approach, representing the antithesis of cost-effectiveness, justifiably garners little support elsewhere.114

Moreover, to be fair, the U.S. framework has significant loopholes. For example, should the loose-lipped executives and their tippees evade insider trading liability when those tippees knowingly trade on material nonpublic information?115 Should one be criminally convicted or totally exonerated on the sole distinction that the confidential information related to a tender offer rather than a merger transaction?116 Should close relatives or good friends be able to trade legally on material nonpublic information when they inadvertently learn of such information when visiting the insider at home or at the office?117 By adhering to a fiduciary relationship-like model that has been rejected by the SEC in the tender-offer scenario,118 the U.S. insider trading approach unduly complicates an already complex area and at times smacks of unfairness among similarly situated market participants.119 For these reasons, many countries opt for an insider trading proscription premised on the “access” doctrine.120 As a generalization, this standard prohibits insider trading by those who have unequal access to the material nonpublic information. This concept may extend the insider trading prohibition to tippees who receive the subject information from traditional insiders or others who, due to their office, employment, or profession, have access to such information.121 This general approach is implemented by such jurisdictions as, for example, Canada (Ontario),122 France,123 Germany,124 Italy,125 Mexico,126 and the United Kingdom,127

A significantly smaller number of jurisdictions opt for an expansive approach premised on the parity of information principle.128 For example, Australia’s prohibition against insider trading generally extends to any person or entity who possesses confidential price-sensitive information.129 Under the Australian framework, one is deemed an insider, thereby becoming subject to the insider trading and tipping proscriptions, by “(a) possess[ing] information that is not generally available but, if the information were generally available, a reasonable person would expect it to have a material effect on the price or value of securities of a body corporate; and (b) … know[ing], or ought reasonably know[ing] that (i) the information is not generally available; and (ii) if it were generally available, it might have a material effect on the price or value of those securities.130

Tipping Liability

With respect to tipping, like the liability of insiders and access persons for trading, the U.S. approach has been thoroughly rejected. Representing an expansive position, Australia, for example, subjects any tippee (regardless of how remote), who knowingly possesses material nonpublic information, from trading on or tipping such information.131 Similarly, the United Kingdom imposes a broad prohibition against trading and tipping by those who knowingly receive material nonpublic information, directly or indirectly, from an insider.132

A number of other countries have approaches that are more straightforward than the U.S. standard but at times not as encompassing. Under German law, for instance, primary insiders may neither trade nor tip. Recipients of material nonpublic information communicated by a primary insider, while subject to the trading proscription, are not themselves precluded from tipping the subject information to others.133 France,134 Italy,135 and Japan136 have similar provisions.

Comments in Favor of U.S. Regulation

The foregoing discussion illustrates that the U.S. approach with respect to insider trading lags behind other established markets in terms of promoting investor protection and market integrity. Nonetheless, in practical reality, the United States regime is viewed as preeminent, irrespective of its shortcomings. The succinct explanation is the implementation of an effective enforcement and remedial U.S. framework that receives widespread support by market participants as well as the general populace.137

As seen by the experiences of many countries, statutes that impose strict standards (such as with respect to insider trading) are meaningful only to the extent that they are enforced with some regularity. The lack or inadequacy of effective government personnel, resources, and surveillance poses little deterrent to prospective violators. Consequently, competent staff must be retained by the applicable regulator and be provided with the appropriate resources to conduct meaningful surveillance and prosecution.138 This commitment has not been forthcoming with great vigor by several countries that have more rigorous standards than the United States.139

Along with this much-relaxed enforcement of statutorily strict standards there are often cultural attitudes acquiescing to insider trading.140 Such practices are perceived by affected participants as embedded to that securities market and as a way that business relations have been conducted for decades (if not centuries).141 This attitude may deter regulators from initiating actions against business executives who are viewed with admiration and respect. Principal reliance on a criminal mode of enforcement (because many countries do not adequately provide for civil enforcement by either the government or allegedly aggrieved private parties)142 may accentuate this reluctance.143 Respected executives thus are faced with penal sanctions in a culture that has not embraced the evils of such “gentlemen’s” offenses.144 Courts also play a key role in this process, often refusing to convict a defendant on the basis of circumstantial evidence145 and imposing relatively lenient sanctions when guilt has been established.146 Although recent developments in certain countries suggest that more successful surveillance and enforcement practices are being deployed,147 a long road must be traversed to approach the effectiveness of U.S. civil and criminal enforcement.148

Hence, irrespective of the apparent laxity and confusion in the U.S. law of insider trading, the U.S. regime remains preeminent. The SEC’s important role as regulator, with its capable personnel, resources, and surveillance, is perhaps the most significant ingredient in effective enforcement of the U.S. securities laws.149 In addition, enhanced criminal prosecution for insider trading has become an accepted component of the enforcement landscape.150 As a further layer of enforcement, allegedly aggrieved traders may institute civil actions seeking damages against those who illegally traded on the basis of, or tipped, material nonpublic information.151

In the United States, the impropriety of insider trading and like offenses152 is generally accepted by market participants, the public, and the judiciary. In other words, unlike in many other countries, the cultural attitudes prevalent in the United States favor relatively rigorous enforcement and prosecution of these offenses.153 Judges contribute to this atmosphere by upholding insider trading convictions based on circumstantial evidence154 and by, pursuant to federal sentencing guidelines,155 imposing lengthy periods of incarceration where circumstances warrant.156 Thus, as compared with other jurisdictions, U.S. enforcement in this area is effective, thereby inducing law compliance157 and facilitating market integrity.158

Concluding Observations

U.S. regulation of insider trading practices is far from ideal. Without adequate justification, ambiguity, complexity, and uneven treatment of similarly situated market participants too often prevail. Perhaps recognizing these shortcomings, countries with developed securities markets largely have declined to adhere to U.S. standards in the insider trading area. The approaches adopted by many countries abroad thus represent an effort to provide clear statutory direction with respect to the insider trading proscription. Focusing on the statutes by themselves, these countries may have largely achieved their objectives.159

Nonetheless, due to such deficiencies as inadequate funding, personnel, resources, and surveillance, ineffective enforcement generally has been predominant in markets abroad. Laws normally are as potent as their effective implementation. The deterrent impact of rigorous statutes recedes drastically as the likelihood of successful usage lessens. Hence, statutes that are intended to enhance market integrity and investor protection have a relatively negligible effect if there exists widespread noncompliance. The lack of successful enforcement thereby facilitates disobedience by market participants to applicable statutory mandates.160

This scenario explains why the U.S. markets are perhaps the most admired in the world. As discussed above, the legal proscriptions relating to insider trading are not without their shortcomings. Although far from ideal, the standards adopted are perceived as within the range of acceptability and have become embedded in the ethos of the U.S. capital markets. Even more significant, these standards are effectively enforced by the U.S. SEC, the U.S. Department of Justice in criminal proceedings, and private litigants who seek damages from alleged violators. Hence, reasonably effective enforcement of statutory, judicial, and regulatory pronouncements that define specified conduct as being unlawful enhances compliance with the rule of law as well as investor confidence in market integrity.

Many countries, including those that are members of the European Community, are devoting significantly greater resources to successful implementation of their statutory mandates relating to abusive practices such as insider trading. Sufficient allocation of resources, of course, encompasses procuring adequate funding, personnel, and technological surveillance mechanisms. Agendas also should include educational or enlightenment missions to stress the importance of these statutory prohibitions to affected constituencies, such as corporate insiders, bankers, legislators, judges, and the investing public. Once reasonably successful enforcement of legal mandates ensues and is perceived in that fashion by market participants, the affected country’s securities markets will be deemed more attractive as a forum for both capital raising and investment purposes.161

[M]aterial information becomes public in either of two ways. The first view is that information that is disseminated and absorbed by the investment community is public. The second view is premised on the efficient market theory, and under this view, information is deemed public when the active investment community is aware of such information. Under the efficient market theory, information that is known by the investment community will be reflected in the price of an efficiently traded security.

Id. (“The basis for recognizing this fiduciary duty is not simply that such persons acquired nonpublic corporate information, but rather that they have entered into a special confidential relationship in the conduct of the business of the enterprise and are given access to information solely for corporate purposes”).

Id. at 664 (opining that “[t]he tip and trade resemble trading by the insider followed by a gift of the profits to the recipient”); Steinberg, supra note 1, at 111. See Hiler, “Dirks v. SEC—A Study in Cause and Effect,” 43 Md. L. Rev. 292 (1984).

“By its narrow construction of § 10(b) and Rule 10b-5, the Court places the federal securities laws in the rearguard of this movement, a position opposite to the expectations of Congress at the time the securities laws were enacted…. I cannot agree that the statute and Rule are so limited. The Court has observed that the securities laws were not intended to replicate the law of fiduciary relations. Rather, their purpose is to ensure the fair and honest functioning of impersonal national securities markets where common-law protections have proved inadequate. As Congress itself has recognized, it is integral to this purpose to assure that dealing in securities is fair and without undue preferences or advantages among investors.”

See, e.g., United States v. Naftalin, 441 U.S. 768 (1979) (stating that purposes of the Securities Exchange Act include “investor protection,” achieving “a high standard of business ethics…in every facet of the securities industry,” and observing that “the welfare of investors and financial intermediaries are inextricably linked—frauds perpetrated upon either business or investors can redound to the detriment of the other and to the economy as a whole”).

“[F]amily members who have benefitted from the family’s control of the corporation are under a duty not to disclose confidential corporate information that comes to them in the ordinary course of family affairs. In the case of family-controlled corporations, family and business affairs are necessarily intertwined, and it is inevitable that from time to time normal familial interactions will lead to the revelation of confidential corporate matters to various family members. Indeed, the very nature of familial relationships may cause the disclosure of corporate matters to avoid misunderstandings among family members or suggestions that a family member is unworthy of trust.”

In 1989, the Council of the European Communities promulgated the European Economic Community Directive Coordinating Regulation on Insider Trading. Council Directive 89/592 of November 13, 1989, Coordinating Regulations on Insider Dealing 1989 OJ (L 344) 30 (“the Directive”). The Directive, for example, sets forth minimum standards for defining the concepts “inside information” and “insider” with respect to which member States of the European Union must comply (Directive, Art. 5) Nonetheless, significant details regarding methods of enforcement are left principally to the member states (Directive, Art. 8). See Pingel, “The EC Directive of 1989, in Insider Trading: The Laws of Europe, the United States and Japan 5, 5-6 (E. Gaillard ed., Deventer: Kluwer Law and Taxation Publ., 1992).

Article I of the Directive provides that inside information is “information which has not been made public of a precise nature…which, if it were made public, would be likely to have a significant effect on the price of the… security.” Article 2 sets forth that an insider is “any person who…by virtue of his membership of the administrative, management or supervisory bodies of the issuer, by virtue of his holding in the capital of the issuer, or because he has access…by virtue of the exercise of his employment, profession or duties, possesses inside information [and takes] advantage of that information with full knowledge of the facts by acquiring or disposing of for his own account or for the account of a third party, either directly or indirectly, transferable securities of the issuer…to which that information relates.” Article 4 provides that a “secondary insider” is “any person [other than a primary insider] who with full knowledge of the facts possesses inside information, the direct or indirect source of which could not be other than a [primary insider].”

The Directive, providing minimum standards only, leaves to the judgment of the member states whether to adhere to more stringent requirements than those promulgated in the Directive (Directive, Art. 6). The Directive mandates that each member state designate competent authorities “to ensure that the provisions adopted pursuant to [the] Directive are applied [and that those authorities] be given all supervisory and investigatory powers that are necessary for the exercise of their functions” (Directive, Art. 6). The Directive declines to require whether administrative, civil, or criminal sanctions should be implemented by each member state for enforcement purposes. Rather, Article 13 provides that “[e]ach member state shall determine the penalties to be applied for infringement of the measures taken pursuant to [the] Directive.” See Steinberg, supra note 1, at 122-23. See also, “New Curbs on Insider Trading, Market Abuse Agreed to by EU Parliament,” 34 Sec. Reg. & L. Rep. (BNA) 432 (2002).

The ambiguity of the United Kingdom’s definition of inside information has been criticized. See Stamp and Welsh, “United Kingdom” in International Insider Dealing 95, 100 (M. Stamp and C. Welsh eds., Sweet & Maxwell, 1996). Note that the French judiciary has held that “privileged information” encompasses negotiations relating to a prospective takeover offer by a French company seeking to acquire the securities of a publicly held U.S. corporation. See CA Paris, 6 July 1994, Les Petites Affiches (Petites Affiches) o. 137, 16 Nov. 1994, p. 17, note Ducouloux-Favard, discussed in Peterson, “France,” in International Insider Dealing 152, 156 (M. Stamp and C. Welsh eds., Sweet & Maxwell, 1996).

See Krause, “The German Securities Trading Act (1994): A Ban on Insider Trading and an Issuer’s Affirmative Duty to Disclose Material Nonpublic Information,” 30 Int’l Law 555, 562 (1996) (“Neither the German Act nor the EC Insider Trading Directive offer guidance as to when information should be considered known to the public”). Cf. Australian Corporations Law § 1002B(2) (setting forth that information is generally available if “(a) it consists of readily observable matter; or (b) without limiting the generality of paragraph (a), both the following subparagraphs apply: (i) it has been made known in a manner that would, or would be likely to, bring it to the attention of persons who commonly invest in securities of bodies corporate of a kind whose price or value might be affected by the information; and (ii) since it was so made known, a reasonable period for it to be disseminated among such persons has elapsed”).

Ontario Securities Act § 1(1) (defining a material fact as a “fact that significantly affects or would reasonably be expected to have a significant effect on, the market price or value of securities [of the subject issuer]”)

Note that there is no federal securities law in Canada. Rather, regulation is provided by each of that country’s 10 provinces and 2 territories. The Ontario securities legislation is viewed as the most significant and will be used as the exemplar in this paper. See generally, Anisman, “The Proposals for a Securities Market Law for Canada: Purpose and Process,” 19 Osgoode Hall L.J. 330 (1981).

(a) [P]ersons holding privileged information by reason of their capacity as members of management, board of directors of an issuer, or by reason of their functions which they exercise with respect to an issuer; (b) [p]ersons holding privileged information by reason of the planning and execution of a financial operation: (c) [p]ersons to whom privileged information is disclosed during the exercise of their professional activities or functions; and (d) [p]ersons who, with full knowledge of the facts, possess privileged information originating directly or indirectly from [any of the foregoing insiders].

Primary insiders are prohibited from trading on inside information for their own account or for the account of others, conveying inside information to others without proper authorization, and making recommendations to a third party to trade based upon inside information (tipping). Secondary insiders are prohibited from trading for their own account or for the account of others. Unlike primary insiders, secondary insiders are neither prohibited from disclosing information to other people nor from tipping. However, the recipients of such information would then become secondary insiders (tippees) and thus would be prohibited from trading on the inside information for their own account or for the account of others. Nonetheless, tippees can continue to pass along inside information provided that they do not trade on it themselves or for the account of others. This result may be explained as a means of facilitating the free flow of information in order to more expeditiously transform non-public inside information into public information.

See Tunc, A French Lawyer Looks at American Corporation Laws and Securities Regulation, 130 U. Pa. L. Rev. 757, 762 (1982) (stating that in France tipping of material nonpublic information is perceived as “a social duty…expected of relatives and friends”); supra sources cited in note 140.

In Germany, the first conviction for insider trading was not procured until 1995; moreover, no prison sentence was ordered. See “Commerzbank Declines to Comment on Report of Insider-Trading Case,” Wall St. J., Aug. 22, 1995, at 10. See also, “Ex-Lawyer Gets Suspended Term for Insider Trading,” Japan Weekly Monitor, Aug. 4, 1997.

See “New Curbs on Insider Trading, Market Abuse Agreed to by EU Parliament,” 34 Sec. Reg. & L. Rep. (BNA) 432, 433 (2002) (stating that from 1995 through 2000, there were “only 13 successful prosecutions leading to criminal penalties across the 17 nations of [the] European Union and its neighbors in the European Economic Area”); Nasser, supra note 140, at 377 (stating that in addition to Canada and Japan, “insider trading seems to go largely unpunished in Australia, France, Germany, and Mexico”).